What Is the Difference Between a Prime and Subprime Loan?

What Is a Prime Loan?

Prime loans are loans that are available to prime borrowers, or borrowers with good credit. Lenders may use different credit scoring models and have their own criteria for evaluating credit. Generally, prime borrowers are those with a FICO^® Score^Θ of 670 or higher. Borrowers with FICO^® Scores of 670 to 739 fall into FICO's "good" credit score range and typically qualify for competitive interest rates on loans. A FICO^® Score of 740 or higher is considered super prime and usually qualifies borrowers for the most favorable loan terms and lowest interest rates.

What Is a Subprime Loan?

Subprime loans are loans offered to subprime borrowers, which are generally defined as those with a FICO^® Score of 580 to 669, or fair credit. Just as with prime loans, lenders may have their own standards for determining who qualifies as a subprime borrower. Lenders may deem you high risk if you're new to credit or have serious negative events such as bankruptcy on your credit report.

Learn more: What Are the Different Credit Score Ranges?

Prime vs. Subprime Loans

Subprime loans include the same kinds of loans available to prime borrowers, such as mortgages, personal loans and auto loans. However, subprime loans have some important differences from prime loans.

• Interest rates: Because subprime borrowers are seen as more likely to default than prime borrowers, lenders typically protect themselves by charging higher interest rates for subprime loans. Subprime auto loans may have interest rates more than triple the rates for super prime borrowers, for instance.
• Down payments: When applying for a subprime mortgage or auto loan, you'll usually need to make a larger down payment than for a prime loan of the same size. For example, a prime borrower might qualify for a mortgage with a down payment of just 3%, while a subprime borrower might be asked to make a down payment of 25% or more.
• Loan amounts: Subprime borrowers may be limited to smaller loan amounts than prime borrowers to limit the lender's risk.
• Fees: Origination fees, late payment fees and other lender fees are usually higher for subprime loans.
• Repayment periods: Subprime loans often have longer terms than prime loans. For instance, a subprime car loan might have a 60-month term compared with 36 months for a prime loan of the same amount. Although longer repayment periods mean smaller monthly payments, you'll typically pay more in interest over the life of a longer loan.
• Interest rates: Subprime loans often have adjustable interest rates, which are fixed for a certain period and then adjust every year. When rates adjust, both your monthly payments and total interest could increase, sometimes dramatically.

How Do Prime and Subprime Loans Affect Your Credit Score?

Both subprime and prime loans can affect your credit positively or negatively depending on how you handle the loan. Missing payments or defaulting on a prime or subprime loan can hurt your credit score. Conversely, making prime or subprime loan payments on time can help improve your credit score and could even boost you into the prime range.

To maximize your loan's positive impact on your credit score:

• Check that payments are reported. Before applying for a subprime loan, find out if the lender reports your account to the three consumer credit bureaus: Experian, TransUnion and Equifax. Having your on-time loan payments appear on your credit reports at all three credit bureaus can help to improve your credit.
• Make your payments on time. The timeliness of your payments is the single biggest factor in your FICO^® Score. Set reminders, mark payment due dates on your calendar or set up autopay so you never miss a payment.
• If you do miss a payment, don't panic. Late payments aren't reported to credit bureaus until they are 30 days past due. If your payment is only a few days late, you may have to pay a late fee and other penalties, but it shouldn't affect your credit score.

Should You Get a Subprime Loan?

Each lender has its own definition of what is considered a subprime borrower, so checking your credit score may not conclusively indicate how a specific lender will view you. However, it should give you a general idea of where your credit score falls.

If your credit score is at the high end of the subprime range, you may want to try improving it before applying for a loan. Getting your credit score out of subprime territory could help you qualify for a prime loan instead of a subprime loan, possibly resulting in significant savings.

The higher costs of a subprime loan can add up, especially for larger or longer-term loans. For example, a 30-year subprime mortgage could cost tens of thousands of dollars more than a prime mortgage over the same time period.

On the other hand, if you need money immediately-for instance, to buy a car so you can get to work-you may decide a subprime loan is worth the cost. After getting the loan, you could work on improving your credit score with the goal of refinancing to a lower interest rate once your score reaches prime range.

How to Get a Subprime Loan

If you don't think you'll qualify for a prime loan and need to borrow money now, you'll need to apply for a subprime loan. Follow these steps to get the best subprime loan for you.

• Research lenders. Subprime loans are available from banks, credit unions and online lenders, with some companies specializing in subprime loans. Credit union subprime loans are capped at an annual percentage rate (APR) of 18%, which may save you money. Experian's loan comparison tool can show you auto loans and personal loans you may qualify for based on your credit profile.
• Compare loan offers. To see if you qualify for a loan, get preapproved with several different lenders. Completing all your loan applications within 14 days will minimize any negative impact to your credit score.
• Consider a cosigner. If you can't get approved for a subprime loan on your own, try getting a friend or family member with good credit to cosign on the loan. The cosigner will have to agree to take over repaying the loan if you can't make your payments. The loan will also appear on their credit reports as well as yours, affecting both of your credit.

Tip: Watch out for payday loans and auto title loans. They're often offered to subprime borrowers, but with interest rates and fees of 400% or more, they can leave you deeper in debt than before.

How to Improve Your Credit Score and Become a Prime Loan Borrower

Try these tips to improve your credit score, which can help you get a prime loan.

• Check your credit reports. Get free copies of your credit reports from the three major credit bureaus (Experian, TransUnion and Equifax) through AnnualCreditReport.com. Review them to ensure they are current and accurate. If you believe there's an error, you have the right to dispute information on your credit reports with each of the credit bureaus.
• Pay your bills on time. Bring any late accounts current and make your payments on time going forward. Setting up automatic bill payments can help you avoid missing due dates.
• Pay down debt. Paying down credit card debt helps reduce your credit utilization rate, which could increase your credit score quickly.
• Sign up for Experian Boost^®ø. Experian Boost is a free feature that adds your on-time utility, streaming, phone and eligible rent and insurance payments to your Experian credit report, which could help improve your credit scores.
• Only apply for credit when necessary. An application for credit typically results in a hard inquiry on your credit report, which could cause a small, temporary drop in your credit score.
• Keep existing credit card accounts open. Unless there are prohibitively high annual fees, it's best to keep credit card accounts open even if you aren't using them. Open accounts can enhance your credit mix, lengthen your credit history and lower your credit utilization rate, all of which can help improve your credit score.

The Bottom Line

When you're in the market for a loan, taking a little time to work on your credit score could pay off big. Boosting your credit score from subprime to prime could save you thousands of dollars in interest over the life of your loan. Experian's free credit monitoring service can help you track your progress toward improving your FICO^® Score and alert you of important changes to your credit so you always know exactly where you stand.